Imagine you spend 30 or 40 years saving and investing for retirement. With a long investing horizon, you stick with an aggressive asset allocation of 70% or more in equities. Now it’s time to retire and start spending some of your wealth. How should you invest?

It’s a tricky issue. On the one hand you can’t afford a prolonged bear market because you need to live off of your retirement nest egg. On the other hand, you can’t afford to be too conservative or your portfolio won’t generate the returns you need during what could be a retirement of 30 years or more.

In today’s podcast, Dr. Wade Pfau shares his expertise on how to invest during retirement. Dr. Pfau earned his Ph.D. in economics from Princeton University in 2003. Today he is Professor of Retirement Income at The American College and the Director of Retirement Research for McLean Asset Management and inStream.

In our interview today, we cover several retirement-related topics:

  • How you should invest during retirement
  • What rate of withdrawal is appropriate in retirement
  • His view on robo advisors
  • The importance of keeping fees low
  • His favorite books on retirement income

And here are some of the resources mentioned during the interview:

Wade Pfau Interview

Rob: Dr. Pfau, welcome to the show.

Dr. Pfau: Thanks. It’s a pleasure to be here.

Rob: I’m thrilled that you could take a few minutes to talk with us. I’ve read your work. And, of course, your work is cited pretty much all over the internet so I’ve followed your work for quite some time, so I’m really honored to have you on the show. To start off, why don’t you tell folks about who you are and what you do?

Dr. Pfau: Sure, yes. I have the website I am actively involved in research about retirement income planning which is still a relatively new field. Actually, my job title is, Professor of Retirement Income at the American College. It’s a pretty unique job title in the world as far as I know. No one else has the same job title, but the American College has fun with getting a little bit more variety with professors of ‘something’ at the school. Primarily, now that the American College has the RICP designation (Retirement Income Certified Professionals) which is growing very rapidly is really just focusing on this new field of retirement income planning and how it’s different from traditional saving and accumulating wealth.

Rob: How did you get into this area of research?

Dr. Pfau: I’ve always had some connection, in that going back to my days as a graduate student, my dissertation was about social security reform. Specifically, President Bush (the second Bush) had the proposal to carve out part of social security to create personal retirement accounts, which was basically then just what happens when you are saving and investing and trying to manage your own retirement. So that was really the genesis of it, in terms of the programming I did to simulate how that reform proposal would work, ultimately would tie into general retirement income planning and simulating retirement outcomes for individuals.

Rob: What did you think of his proposal?

Dr. Pfau: At that time I was more mixed that it could potentially work but not necessarily. Usually, advocates of those sorts of proposals will say, “The stock market earns 7 percent after inflation so it’s ridiculous not to just put all your money in the stock market.” And I had a more nuanced approach to that. In hindsight, I realized increasingly as well that for most Americans it really is helpful to have a defined benefit pension. Social security has inflation protection, longevity protection, and market protection. So it’s really very important to start carving up a part of it to create personal accounts and reduce the amount of the traditional social security benefit. I think that would be problematic for a lot of Americans.

Rob: Right. Let me move to a slightly different topic. I get this question a lot from those who listen to this podcast. And that is, as they’re nearing retirement, how should they be investing their money? I know, in fact, you have a recent article on your blog about glide paths. There was some talk about inverse glide paths and all that. Should you go from a lot of equities to fewer equities as you get closer to retirement, and then into retirement? Or should you do something else? What’s your view and what’s the available research out there on how folks should invest their retirement as they are getting near to the age for them to retire?

Dr. Pfau: The way I really think about this is to follow a U-shaped lifetime stock allocation glide path. But I’m comfortable with the notion behind target-date funds and things in the pre-retirement period. When people are young, they tend to have a higher stock allocation and they reduce that stock allocation as they get near their retirement date. How far they reduce it really depends on a case-by-case basis of how comfortable someone is with the market volatility and how much capacity they have to take risks and so forth. But then, the question is: what do you do post-retirement? Traditional target-date funds are generally somehow linked to either holding a steady stock allocation or continuing to decrease the stock allocation post-retirement. I’ve done some research with Michael Kitces where we talk about, actually as a risk management strategy, to gradually increase the stock allocation post-retirement. But that means starting off retirement with a lower stock allocation than you might otherwise have. In response to a lot of the research, there are really two completely different schools of thought about how to plan for retirement. The one school of thought about using an investment portfolio and spending from the portfolio recommends generally that retirees have 50 to 75 percent stocks in retirement. In response to that, I don’t think everyone is comfortable with that high a stock allocation, and they don’t necessarily need to have that high a stock allocation throughout retirement as the basic starting point of this idea of a U-shaped glide-path.

Rob: Let me make sure we understand the U-shape. So this is where, if you were, say 25, you would have significantly more stock. It’s going to vary from person to person but let’s just say someone has 90 percent stocks and 10 percent bonds. On the U-shaped approach, as you near retirement, that’s going to shift to something where the bonds are far more significant than just 10 percent. Maybe it’s 50-50. Maybe you even have more bonds than stocks when you enter retirement. But then as you enter retirement and you start to age and live in retirement, the other side of the U kicks in and you actually start increasing your exposure to equities.

Dr. Pfau: Right. That you have your lowest stock allocation in your lifetime near the retirement date.

Rob: That’s something that I think a lot of people just have never heard before— that in retirement, you’re actually going to make your portfolio more volatile. Why would that be a good thing?

Dr. Pfau: It’s a risk management technique. Actually, when you’re thinking from a household balance sheet perspective of tallying up all the assets and looking at things like social security benefits as an asset, it’s something that’s naturally going to happen for most people anyway, that their stock allocation as a percentage of all their household assets will tend to increase as they age. But I view it more as a risk management strategy that when you look at what are the worst-case scenarios that generate poor retirement outcomes, it’s having poor market returns early in your retirement. If you have good market returns early on and poor market returns later on, you’re generally going to have a successful retirement anyway because you’re already going to be on a trajectory towards success. But if you get the poor market returns early on, well, the really catastrophic scenario is that you have a 30-year retirement with poor market returns the whole way through. And there’s nothing you can really do in that case. But the more realistic type of worst-case scenario is poor market returns early on and then markets get better later on. That’s exactly the kind of scenario that a rising equity glide-path will help you out with compared to just having a high stock allocation the whole time.

Rob: Sure. So with a low stock allocation at retirement, if there’s a bad market, it’s not going to hurt you as much. Then, as you age and you hit 70, 75, or 80, you can increase your equities because, yes, even then you could have a bad market but your investing horizon now is much shorter obviously because you’re older.

Dr. Pfau: Right.

Rob: So, what would be a range of stock-to-bond allocations that the U-shaped approach would suggest at the point of retirement?

Dr. Pfau: It does really vary by person. But as a baseline case study that we’ve looked at in more depth, because we thought it might be pretty realistic for a lot of people, is starting retirement at around 30 percent stocks and increasing over time to 60 percent stocks.

Rob: And I take it you back-tested this?

Dr. Pfau: Right. But again, that’s not a recommendation. We thought that for a lot of people, that might be a reasonable set of numbers.

Rob: So I’m just trying to think this through. I’ve talked to the folks at Vanguard. I’ve had them on this show (Podcast 46). We’ve talked about the 4 percent rule. One of the things they say about the U-shaped is that in addition to the glide path and the impact of bad returns early in retirement, you ought to also recognize that a lot of things change during retirement. We talk about this 30-year period of retirement but our spending requirements tend to change. They tend to go down over time. Now when you’re 65 and retiring, maybe you’re traveling and doing whatever you like to do— you’re playing golf or whatever your thing is. But when you’re 85 or 90, at least most people are doing those sorts of things. So costs go down. The other thing is when you’re 65, even if you retire, if you had to, you probably could go back to work, at least if not full-time, part-time. When you’re 90, maybe that’s not as realistic. So I’m curious if those sorts of considerations impact your view of the U-shaped investment approach?

Dr. Pfau: The idea of your spending decreasing as you age, that would actually help this argument – that you’re less vulnerable at that point because you’re having to withdraw less so you’re less exposed to sequence-of-returns risk as you go through retirement. On the other issue of the reduced flexibility, the main argument, is that as people age and get into their 80s and 90s, we’re not saying they would necessarily ever have a higher stock allocation than the traditional investment-based retirement income strategies are advocating. But nonetheless, they might have gotten used to less volatility earlier on than you’re asking them to take greater volatility later on. That might just psychologically be a problem. Though by that point, if you just have a basic spending goal you’re trying to meet, you’re either going to be on a trajectory to success, where if you’re using a conservative spending rate and you’re not in a worst-case scenario, your wealth is going to continue to grow. The percentage of the portfolio you have to withdraw to meet your spending goal is going to decrease, your time horizon is getting shorter – you really are on a good path to having a successful retirement. So at that point, it’s not going to matter so much what you do, but certainly there are psychological considerations. That’s a valid argument against using it. I’m not saying everyone should use a rising equity glide path. I’m just saying it works as a risk management strategy, and if people would like to consider it, then great; but if they don’t, that’s fine as well.

Rob: Whatever approach they take, whether it’s the U-shaped or the more traditional approach where your equities just slowly decline over time to maybe a point where they just level off, but what’s your view on the 4 percent withdrawal rule? Is that still a valid rule? Is that a good approach to retirement spending?

Dr. Pfau: The 4 percent rule has a lot of simplifying assumptions built into it, because when it was developed in the 1990s, it was to bring expectations down. One of them is that people always just adjust their spending for inflation. That causes unique problems for trying to actually use that as a strategy because that really amplifies the sequence risk: that if you get a poor market return early on and you don’t cut your spending, that really hurts your chances for retirement success. So with that caveat: that real people need to adjust their spending. But if they’re not, if they’re just going to adjust their spending every year for inflation, then I do think that 4 percent is too high in the current environment where interest rates are so low. I think people really don’t understand. They think, “Well, the 4 percent rule is based on the worst-case scenario in US history.” But we’ve got 10-year treasury yields a little bit above 2 percent now, but they were below 2 percent earlier in the year. The only other time in US history that that happened was for a few months around the turn of 1941. Though the 4 percent rule worked in that one case, that’s only one example of ‘if you flip a coin once then you get heads.’ It doesn’t mean you’re safely going to get heads every time you flip the coin in the future. It’s just one time— one experience of a retirement beginning at such a low-interest rate environment. What that means is that in most of the US history, a basic total returns investment portfolio was generating at least 4 percent in terms of interest and dividends. That’s not the case today. A retiree starting today, trying to use the 4 percent withdrawal rate in investing with a total market type investment strategy, they’re going to have to dip in the principal. That’s amplifying the sequence risk. So I don’t think 4 percent is the safest ‘all-rate’ in this environment. I think if you really want to have inflation-adjusted spending, 3 percent is a much more reasonable number than 4 percent when interest rates are so low.

Rob: That of course would increase significantly the amount of money you would need to have saved to generate the same amount of income.

Dr. Pfau: Right. So to the extent that’s not practical, it’s really then a matter of being flexible and being able to adjust spending, if we do get a market decline early in one’s retirement.

Rob: Right. So if you have flexibility in how much you take out each year, you might be able to start at 4 percent— recognizing that if the market is down in a given year, you will either have to forego any inflation adjustment, or possibly, I suppose, even take out a little less than you took out the year before.

Dr. Pfau: Right.

Rob: Is there any sort of research around the mechanics of that— the sort-of floor and ceiling, if you will— if you want to take that sort-of dynamic approach to withdrawals?

Dr. Pfau: Yes, there is. I wrote an article in March called, Making Sense of Variable Spending Strategies, where I tried to compare 10 different strategies. There are a ton of types of strategies that you can find on the internet, and I tried to compare them all on a more equal footing just within the same underlying market assumptions and the same kind of calibration for how much risk there was on the downside. Tara Siegel Bernard wrote about this in the New York Times on May 9th. She had a really great column about it that became the most emailed article in the past 30 days of the New York Times.

Rob: I read that article. It’s very good.

Dr. Pfau: Yes, and it summarized some of the results from my research article.

Rob: Okay, I will track those down and make sure the folks listening have access to those in the show notes. I’m curious, are you familiar with, in terms of retirement spending and investing, the bucket approach? Maybe 3 buckets of investments: one for, say, the first couple of years; maybe a second bucket for years 3 through 10 and the third bucket for spending that will occur beyond 10 years? Are you familiar with that approach?

Dr. Pfau: Yes.

Rob: So what does the research say about retirees taking that approach to investing their money?

Dr. Pfau: I talked about two schools of thought for retirement income: the one that relies only on investments, and then the other extreme is essential versus discretionary of having some sort-of guaranteed floor for essential spending needs, and then taking more risk for the discretionary expenses. I view that bucket or approach as a hybrid that combines elements of both of these schools of thought: that holding fixed income to maturity to cover upcoming expenses reduces the market risk for upcoming spending. That helps to alleviate the sequence-of-returns risk. So it can be a matter of if the retiree uses a 60-40 portfolio of stocks and bonds, the bonds are meant to reduce portfolio volatility. But you could say if I want to have 8 years of income, 8 years of bonds maturing to provide the income that I’m looking for, and it costs about 5 percent of my assets to cover each year, then 40 percent bonds mean I have got an 8-year bond ladder, and the 60 percent stocks then goes into covering expenses for years 9 and beyond. It is based on the idea that if you leave stocks alone for long enough periods of time they are going to grow and you’d be better off, and then having some sort of mechanism in place to move assets from the growth portfolio into the fixed income portfolio over time. In terms of the research about whether this is truly a superior strategy, it doesn’t seem to be the case. It’s just a different way of thinking about asset allocation. But in terms of people’s understanding and behavior and being able to stick to a strategy, it does really seem to be the case that people can understand why their asset allocation is what it is when they are using this sort of bucketed approach. That can help them stay in the course and not panic if there is a stock market decline because they know they don’t need to dip into their stocks for a few years at least. So I think it’s a pretty viable strategy. It’s on an equal footing with other types of investment approaches. Not necessarily superior, not necessarily inferior; but nonetheless, may be superior just in terms of the people being able to follow this strategy better. The worst thing that a person can do is panic and sell their stocks after a market decline. If they’re more likely to do that with the traditional asset allocation stock and bond funds, then that’s not good. So that would definitely lean in favor of the bucketing approach.

Rob: You mentioned the word “historically low-interest rates.” What do you think is going to happen to stock and bonds when interest rates rise?

Dr. Pfau: Bond prices will naturally decline if and when interest rates rise. That’s just the mathematical link that as interest rates go up, bond prices decline. For stocks, it depends more on the reason for the interest rate increase. Whether it is being caused by inflation or being caused by the underlying real interest rate. It’s a little bit harder. I don’t like forecasting too much because most of the time that you hear a forecast, it ends up being wrong anyway. But certainly there is some potential for stocks that there could be some panic, and for stocks to decline if interest rates suddenly start rising rapidly.

Rob: I’m just throwing different topics at you, but are you familiar with the automated investment services? The robo-advisors like Betterment and Wealthfront?

Dr. Pfau: Yes.

Rob: Do you have opinions on those types of services as it relates to investing, and even investing into retirement?

Dr. Pfau: Well, investing in retirement is a whole different story. I don’t think they’ve made any progress in that regard, because they’re really just traditional asset wealth accumulation types (saving for retirement, not post-retirement distributions). I know some of the guys at Betterment. They’re just trying to play a game of catch up and having something for their retirement distribution, but it’s not well thought out at all. In terms of pre-retirement, I think what they’re ultimately doing is showing that, because I tend to be somewhat of a passive investor myself, investing has been commoditized. Now, it’s shown to be worth 30 basis points or 0.3 percent fee, so that financial advisors who are charging 1 percent need to provide more value than just investment management. If they are not providing more value, they are probably going to go out of business. But if they are providing more value, there are a lot of great things that financial advisors can do for their clients that could more than compensate for a 1 percent fee. Simply now there are robo-advisors for advisors, where they can outsource the investment management piece and pay that 30 basis points of the fees, keep the other 70 basis points, and do financial planning (taxes, estate planning, and everything else that there is to do). Ultimately, those robo-advisors, they’re probably going to drive some advisors out of business. But I think good financial planners will be able to compete for a long time still, because the robo-advisors are really just simplified: building an asset allocation based on a few questions, and trying to get a basic risk tolerance.

Rob: I think I agree with that. I think investment advisors will be around for a long time for a couple of reasons: some people just aren’t knowledgeable enough to appreciate the significance of a 1 percent fee. I talk to them all the time. They come to me and, before they listened to this podcast, had no idea what the impact is. One percent seems like such a small amount.

Dr. Pfau: Yes, but when it compounds of time…

Rob: So a lot of people just don’t even appreciate the significance of that. The interesting thing for me, though, is you mentioned that these advisors have to provide services beyond just asset management in order to justify the fee. I’m not so sure they can do that. I’m certain they provide a lot of great services and they can justify an hourly fee for those services. But to justify a 1 percent fee? I mean, the numbers get enormous over 20, 30, or 40 years of investing.

Dr. Pfau: Yes, the tyranny of compounding fees. If it’s a good advisor though with tax planning and everything else, it’s possible to leave— and also just having a good asset allocation. Someone left to their own devices, may, if they are good at all this. But if they make so many mistakes with their finances, then they would be much better off paying a 1 percent fee by having a better overall plan.

Rob: Sure. I noticed on your website you have something called, “the retirement income dashboard.” What is that?

Dr. Pfau: The dashboard is an attempt to summarize the two different schools of thought about retirement income planning. So based on today’s interest rates and today’s annuity payout rates (which of course are linked to interest rates and everything else), what are reasonable estimates for sustainable retirement income for a 65-year-old couple (right now it’s just set-up for a 65-year-old couple, but I hope to expand that) currently, for somebody retiring today, and going well beyond just applying the 4 percent rule randomly, but really linking it to today’s interest rate environment and how that impacts retirement income.

Rob: So what’s the conclusion?

Dr. Pfau: The conclusion is that with interest rates so low, you should expect less than 4 percent but then it’s a matter of if you want to go with an investments only type strategy in terms of stocks and bonds funds? Or if you want to use some sort of dedicated income, whether that be holding individual bonds to maturity or using income annuities which provide risk pooling and for longevity protection as well? One of the main conclusions coming out of it that people have to understand with an investments-only strategy is you have to be extra conservative because you’re planning to live a very long time and you have to assume poor market returns as well. The safe spending rate is going to be less than you could get if you were to build, for example, a 30-year bond ladder which doesn’t have longevity protection; or using an income annuity just because of that additional conservatism. It has more upside potential with investments but the downside risk is there, and that forces greater conservatism. Also, the flexibility piece, if you’re willing to adjust your spending in response to poor market returns, you can start spending at a higher initial rate. But nonetheless, all the numbers on the dashboard are generally depending on your strategy and approach, somewhere in the ballpark of between 3 and 5 percent as an initial spending rate in retirement.

Rob: Okay. I’m curious. Do you have any books that you found to be particularly good in terms of retirement spending and retirement investing?

Dr. Pfau: Oh, book recommendations.

Rob: Yes, I didn’t warn you about this question.

Dr. Pfau: It’s a little bit more technical but it’s really good— Michael Zwecher’s, Retirement Portfolios.

Rob: Right, that’s one that I’ve heard of.

Dr. Pfau: I’m trying to write a book myself but it’s not ready yet, so I can’t recommend that one.

Rob: When do you think it will be ready?

Dr. Pfau: I’m hoping by the end of the year.

Rob: Okay.

Dr. Pfau: Harold Evensky and Deena Katz wrote, Retirement Income Redesigned. It’s more like a textbook in that each chapter’s by a different author. It was published in 2006 so it’s getting a little outdated but it’s a really good book too.

Rob: Okay. I’ll put both of those in the show notes so people can check them out. This has been very helpful. The one thing that can be frustrating for folks is that with all of this, is that, correct me if I’m wrong, there’s no single one right answer. There are issues to consider. There are pros and cons with one approach versus another approach. Sometimes folks just want to hear the answer, and I’m not so sure that exists in the area of retirement investing and retirement spending.

Dr. Pfau: Right. This is an issue where sometimes people spend more time looking at how to save $20 when they buy the next vacuum cleaner, then they do thinking about how they’re going to approach retirement income planning, how they should claim social security and everything else. Some of those decisions can add up to $100,000 or more over a lifetime. So it’s important to spend the time and really think through the issues and decide what’s the best approach for you.

Rob: Yes, the social security issue is immensely complicated and when I get to that age, I’m simply going to hire someone to tell me what the best approach is because there’s just too many options and too many factors that’s hard for me to wrap my mind around on the social security front. Well listen, I really appreciate your time. Is there anything I’ve missed? Any work you’re doing now that you want to share with us in this area?

Dr. Pfau: As of this time, I’m trying to work on the book. I’m still trying to fill in a few holes. So, I’m looking at reverse mortgages: can they potentially play an interesting role as part of an overall strategy? They can be abused in many ways but there’s some research that shows favorably, how reverse mortgages can be used in retirement income, how to just use income annuities, whether to use immediate annuity or deferred income annuity, and how that can fit into a retirement plan. There’s just a lot of different ways to think about retirement income planning.

Rob: Will your book cover those issues?

Dr. Pfau: Yes.

Rob: Good, we’re looking forward to it. Are there reverse mortgages out there that don’t kill you with fees?

Dr. Pfau: I think there are even some now that build the fees into the interest rate. One of the really interesting ways to use the reverse mortgage is to just simply open the line of credit at age 62, and then you may never actually have to use it. So if it has a little bit higher interest rate, you can get close to eliminating any sort of upfront fees.

Rob: So they have reverse mortgages that act like a line of credit rather than giving you a lump sum and saying, “Here it is.”

Dr. Pfau: Yes, the government has increasingly made it more difficult to get lump-sum amounts, because that’s how people were getting into the shady practices of taking out their home equity, putting it into some investments and then moving everything. But the government’s really been cracking down on that.

Rob: So you could open up a line of credit type of reverse mortgage and as you say, you may never need it or use it, but it’s there if you have to.

Dr. Pfau: Yes. The one article I have finished and published so far was about really just as a way to protect the home value especially when interest rates are low. This is something usually that’s bad for most investments but it’s nice for opening a reverse mortgage when interest rates are low because the initial line of credit will be higher. Then, because it has a variable interest rate, the line of credit will grow throughout retirement. If interest rates go up and if you end up living in your home long enough, at some point your line of credit could grow to be worth more than the value of your home— and it’s a non-recourse loan. You can get a windfall and you can protect the value of your home that way. If your line of credit is worth $400,000 and you think your home is worth $300,000, take out the $400,000 and you’re done with it.

Rob: Interesting. Because obviously on an annuity the lower rates are going to hurt you. But on a reverse mortgage, they help you.

Dr. Pfau: Yes, because they get you a higher initial line of credit.

Rob: I will track down that article that you wrote. Is it on your website? Or is it on another publication?

Dr. Pfau: It’s from Advisor Perspectives. I’m sure I have a link to it from my website.

Rob: I’ll track it down. Well great! This has been very helpful. I appreciate it. We look forward to your new book. And thank you for being on the show.

Dr. Pfau: Okay, thank you. It’s been a pleasure talking with you.


  • Rob Berger

    Rob Berger is the founder of Dough Roller and the Dough Roller Money Podcast. A former securities law attorney and Forbes deputy editor, Rob is the author of the book Retire Before Mom and Dad. He educates independent investors on his YouTube channel and at